As far back as the beginning of this year in January, Dr. Jim Walker was already alerting the US monetary authorities that US inflation and monetary policy had to go beyond analyzing the Consumer Price Index (CPI).
In an article entitled “Bits and Pieces,” he warned that inflation is a many-headed beast. Consumer prices, producer prices, commodity prices, asset prices, and the GDP deflator are all measures of “inflation.” But there are other elements involved in the inflation story, especially debt in the case of the US. Monetary policy in the US over the last decade has encouraged the buildup of debt, especially by the government, on a gigantic scale.
Dr. Walker has been insisting for some time that the Federal Reserve System has been using consumer price inflation as a proxy to its real war. This is a consequence of the dual mandate policy of the Fed: price stability and full employment. The reality, however, is that the Fed opened Pandora’s Box with its ultra-easy monetary policies and now needs to restore discipline in markets on several fronts (including allowing markets to function). While conditions are conducive — CPI above 2%, the labor market supposedly tight, Atlanta Fed GDP Nowcasts above 4% and, most importantly, no signs of financial distress — the Fed will continue to raise interest rates. Indeed, the Fed kept raising interest rates over the following months.
Fast forward to May. Dr. Walker comments that in the debate around rate hikes, the role of inflation seems to be taking a back seat. In many circles, the assumption is that the fight is won, at least in the US. National consumer price inflation has fallen back to 5% year on year and six-month annualized is at just 3.6%. Many are concluding that the Fed has been successful in fighting inflation and that the next move in interest rates will be down. Dr. Walker disagrees and is of the opinion that the Fed Funds rate will hit 6% in the current cycle and that the 10-year US Treasury will be a buy at 4.5%.
In Europe, the fight against inflation is far from being won. In fact, Dr. Walker observes that there are misinformed accusations of “greedflation” against corporations who are being blamed for the lingering European inflation because they have become “greedy” and wish to take advantage of high prices to pad their profits. Dr. Walker thinks this idea is nonsense and, in his words, “economic illiteracy at large.” Is it really possible that rational businesspeople will take advantage of poor, dumb consumers by encouraging inflationary forces? If this is so, it wouldn’t be the consumers who are dumb, it would be the corporates.
Elementary microeconomics teaches that the higher price, the fewer units of the good or service would be demanded. Depending on demand elasticity (some goods and services are certainly less price sensitive than others), the reaction of consumers to rising prices will be one thing and one thing only: a smaller quantity purchase. If companies wish to reduce sales (which is hardly rational), they will certainly push their prices upwards. Unless, of course, that is the only way to cover increased costs — including capital — or maintain margins. There is one other circumstance which can ameliorate higher prices and help maintain sales. If governments and central banks print excessive amounts of money, consumer inflation and sustained quantities of demand can be accommodated. The problem is that the ensuing money inflation is conning businesses into thinking that they are making money when, in fact, profits are shrinking/stable/rising/imaginary. No one can really tell until the money-go-round stops.
Elementary supply and demand economics also tells us that if companies are truly hiking prices to make bigger profits, supply will rise as price (and) profit increases. These allegedly greedy businesspeople are, therefore, playing an unwinnable game. Either their price rises choke off demand or they induce more competition from new suppliers. It is unthinkable that businesspeople are unaware of these consequences. It is more realistic to assume that they are just more aware of the pernicious nature of inflation and the lagged ability of historic cost accounting to properly identify relative price and cost shifts.
The lessons for the Philippines are obvious. Bringing down inflation should be the highest priority of monetary authorities. It is comforting to know that there is a high probability that by the last quarter of this year, inflation will be back to the 2-4% level that was the rule before the pandemic. The Central Bank should think twice before starting to bring down interest rates. It is worthwhile to cite here what Dr. Walker quotes from the famous economist Ludwig von Mises: “It would be a serious blunder to neglect the fact that inflation also generates forces which tend towards capital consumption. One of its consequences is that it falsifies economic calculation and accounting. It produces the phenomenon of imaginary or apparent profits.”
As I have insisted time and time again, the second biggest economic challenge to this present Administration — after improving agricultural productivity — is to increase our investment to GDP ratio to levels commensurate with those of our East Asian neighbors of more than 30% of GDP from present levels of 22% to 23%. Capital consumption induced by the mirage brought about by inflation leads to exactly the opposite direction, to decrease even further our investment-to-GDP ratio.
As a final word on lessons from the US debt crisis, let me hammer what Dr. Walker repeatedly wrote in several of his Peregrinations: Increased government debt and ultra-low interest rates are millstones around the necks of the economic actors throughout the advanced economies. The wrong signals have been sent and the result is weak growth, lower productivity and a massive debt overhang. Especially in the case of Japan, recession lies ahead in 2023 and 2024. In contrast, East Asian countries have generally maintained a degree of sound money discipline and fiscal responsibility. Average real GDP growth rates through the Bernanke Doctrine years have held up well in China, India, Indonesia, Malaysia, the Philippines, and Vietnam. In all countries, government debt levels are well below those reported by the Big 3 advanced economies at the turn of the millennium and even post-pandemic.
I am confident that our own monetary and fiscal managers will continue to follow the prudent measures that have prevailed in the Philippines over the last two decades. That is why I am confident that the 6-7% GDP growth rate in most economic forecasts for the Philippines (both government and private sector) is very attainable.
(To be continued.)
Bernardo M. Villegas has a Ph.D. in Economics from Harvard, is professor emeritus at the University of Asia and the Pacific, and a visiting professor at the IESE Business School in Barcelona, Spain. He was a member of the 1986 Constitutional Commission.